2010 (9) TMI 749 - AT - Income Tax

Partial win for Assessee: Compensation & telephone expenses allowed. Analysis of tax provisions & DTAA.

The ITAT partially allowed the Assessee's appeal, overturning the disallowance of compensation under section 40(a) of the Income-tax Act and the ad-hoc ... Disallowance u/s.40(a) - The assessee had made the provision of Rs.38,41,257/- in respect of the compensation to be paid to foreign company namely M/S. Swissgen NV of London (UK) and claimed the same as an expenditure in the profit and loss account - nature of compensation - Held that:- both the parties have not understood the issue in a proper prospective. So far as character of the compensation is concerned, in our opinion, it is a business profit and is covered under Article 7 of DTAA of UK and India as it is arising out of the trading contract.TDS on interest paid on compensation - Held that:- interest partake the character of the compensation. - there was no justification for disallowing amount of the compensation claimed by the assessee on the reason for non-deduction of the tax.Disallowance of telephone and mobile expenses - nothing is there on record to show that the telephone was used for non-business purposes. - If the assessee has claimed any expenditure and A.O. desires to make the disallowance then the proper way is to identify the element, which does not relate to the business of the assessee. - the ad-hoc disallowance is not justified. Issues:1. Disallowance of compensation under section 40(a) of the Income-tax Act2. Disallowance of telephone expenditureAnalysis:1. Disallowance of compensation under section 40(a) of the Income-tax Act:The dispute arose regarding the disallowance of Rs.38,41,257 under section 40(a) of the Income-tax Act concerning the payment of compensation to a non-resident company. The Assessee claimed the compensation as an expenditure in the profit and loss account, which was related to a contract for the supply of goods to a foreign buyer. The Assessing Officer disallowed the claim citing various reasons, including tax deduction obligations under section 195 and taxability under section 9(1)(i). The Learned CIT (A) upheld the disallowance, emphasizing the lack of clarity on the role of an intermediary in the deal and the tax deduction obligations. However, the ITAT Mumbai analyzed the case comprehensively, considering the DTAA between India and the UK, the nature of the compensation, and the presence of a Permanent Establishment (PE) in India. The ITAT concluded that the compensation was not taxable in India as the non-resident company had no PE in India, and there was no obligation to deduct tax under section 195(1). The ITAT also addressed the interest component in the compensation, asserting that it assumed the character of a judgment debt, following a precedent set by the Hon'ble High Court of Bombay.2. Disallowance of telephone expenditure:The second issue involved the disallowance of telephone expenses amounting to Rs.60,790. The Assessing Officer made an ad-hoc disallowance based on expenses related to mobile usage and telephones installed at the partners' residences. However, the ITAT found the ad-hoc disallowance unjustified as there was no evidence to suggest non-business usage of the telephones. The ITAT emphasized the importance of identifying specific non-business elements before making any disallowances. Consequently, the ad-hoc disallowance was deleted, and the telephone expenses were deemed justified.In conclusion, the ITAT partially allowed the Assessee's appeal, overturning the disallowance of compensation under section 40(a) and the ad-hoc disallowance of telephone expenses. The decision was based on a thorough analysis of the tax provisions, DTAA implications, and the nature of expenses incurred by the Assessee.